Follow Up

FedEx Can Still Deliver

Slowing growth in China and the European economic crisis are weighing on the shares of the the global delivery giant. But helped by a growing domestic ground delivery business, they won't be grounded for long.

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Fred Smith was largely upbeat when we profiled the
FedExFDX -0.36764705882352944%FedEx Corp.U.S.: NYSEUSD176.15
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1271818AFTER HOURSUSD176.15
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22.202561333767136Market Cap
50089737192.7276
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0.45415838773772355% Rev. per Employee
288660More quote details and news »FDXinYour ValueYour ChangeShort position
founder and CEO last year, though he conceded there was still much that could go awry, including higher energy prices and gridlock in Washington ("Lead, Have a Clear Strategy, Delegate," Aug. 1, 2011). His caution proved warranted. Last week the global shipping giant said earnings for its fiscal first quarter, ended in May, would be weaker than it had previously forecast.

FedEx is scheduled to announce fiscal first-quarter results on Sept. 18. Smith was unavailable to comment in advance of the earnings news.

Rising fuel prices were indeed a factor in the FedEx (ticker: FDX) earnings miss. But "constrained revenue growth" in the company's global air-shipping network—62% of the company's $42.7 billion in sales last year—was the bigger drag on earnings, due to a slowdown in China's growth and the European economic crisis.

FedEx shares, which closed the week at $87.38, initially dipped on the news, but have since recovered. They could move up 15% or so in the next year, as the company boosts its fast-growing domestic ground-delivery business and pares back costs.

Still, many observers view the pre-announcement as cause for alarm, including some of our colleagues at Barrons.com, cautioning on Sept. 5 that FedEx could be "boxed in" by the global slump.

Others, like Rob Pickels, a senior equity analyst at asset manager Manning & Napier, note that dealing with cyclicality is part of FedEx's DNA. "That is a risk you understand as an investor in FedEx," says Pickels. "Over the long run, this company will be successful managing through these cycles." Manning & Napier has an $86.5 million stake in FedEx.

On the global front, the company is taking steps to make its global network more efficient, including the addition of more fuel-efficient Boeing 777Fs. It can also cut back its costly domestic air-delivery network, as FedEx Ground supplants it.

Francesca's (ticker: FRAN) 41-year-old CEO, John DeMeritt, announced plans last week to retire at year end to "pursue personal endeavors." In July, co-founder and board member Kyong Gill stepped down. And in May, CFO Gene Morphis was terminated for inappropriate comments online; a permanent replacement hasn't been announced. In the past 14 months, the company and its insiders, along with the firm's private equity investor, have sold more than 30 million shares in an initial public offering and two secondary offerings.

Amid the shakeup, Francesca's, which sells women's clothing and accessories, reported a 21% jump in second-quarter same-store sales. Total sales jumped 49% in the period; operating income surged 65%, and earnings per share more than doubled. The company says it is on track to open 77 stores by the end of this year, pushing the total to 360. Another 75 are projected in 2013.

Investors seem to think this sounds too good to be true, and appear concerned about the company's changing leadership. Shares fell 23% last week, to $27.87, on strong volume. On Wednesday alone almost 10 million shares traded hands; that's nearly a third of the publicly traded shares and 10 times the average daily volume.

The stock is down 7% since our negative story on the company ("No Margin for Error," April 23); the market is up 4% in the same period.

We raised concerns about Francesca's ability to maintain profit margins that were well above those of the industry. So far margins are up even more, to 54.8% in the latest quarter, up from 52.7% in 2011. Another worry was that two key suppliers are related to the company's co-founders. Some bears suspect the company's high margins are related to preferential treatment.

Even with the pullback, Francesca's looks pricey at 25 times next year's estimated profits. If another shoe drops, the shares could fall, too.

-- Jacqueline Doherty

More Trouble for a Chinese Reverse Merger

The products of Chinese reverse mergers just keep making news, most of it unflattering.

The latest is
China Sky One Medical
(CSKI), which the Securities and Exchange Commission charged last week with fraudulently recording phony sales of a weight-loss product and inflating revenues in 2007 and 2008. Barron's has written many times about possible accounting problems at Chinese companies listed on U.S. exchanges through reverse mergers, which permit them to go public with less disclosure than a normal IPO.

In a story that mentioned China Sky ("Who's Minding the Minders of Chinese Accounting?" Feb. 18, 2008), we also raised questions about U.S. auditors of reverse-merger companies, which in some cases had conflicts of interest or other issues. We noted that China Sky's auditors, Boca Raton, Fla.-based Sherb, had reporting "deficiencies" cited in an inspection by regulators at the Public Company Accounting Oversight Board, and also were accused in a class-action suit of signing off on alleged revenue fabrication for another company. At the time, a Sherb official said the PCAOB comments weren't unusual for auditor inspections and that the suit had been settled. A couple months later, China Sky replaced Sherb with another accountant, Moore Stephens, or MSPC. Neither Sherb nor MSPC were named in the SEC's civil complaint.

In 2009, a Website, waldomushman.com, noted discrepancies between China Sky's Mainland and U.S. regulatory filings. That set off a stock slide, litigation, and delisting. MSPC later resigned as auditor. The SEC charges covered periods during which Sherb and MSPC audited the firm. "We don't comment, and we stand by our audit report," says Michael Kayser, a partner at MSPC. We couldn't reach Sherb or China Sky.

Expect more contention on this issue: China's Xinhua News service last week asked the SEC to investigate short sellers of reverse mergers.